Marginal Utility Of Consumption Research Articles

The Effect of Health State on the Marginal Utility of Consumption: Evidence Based on Household Consumption Expenditure

The Effect of Health State on the Marginal Utility of Consumption: Evidence Based on Household Consumption Expenditure

Horizon effect on optimal retirement decision

We study an optimal consumption, investment, life insurance, and retirement decision of an economic agent who has an option to retire early any time before the mandatory retirement date. We conduct a thorough theoretical analysis for the optimal retirement problem with general utility function in the presence of a mandatory retirement date, which leads to the optimal stopping problem in finite horizon. Furthermore, the different marginal utility of consumption before and after retirement is considered, which can provide an explanation for the retirement-consumption puzzle, while it makes the problem technically more challenging. Based on the theory of partial differential equation, we analyze the variational inequality arising from the dual problem and establish the duality theorem. We show that the optimal retirement decision is determined by the time-varying optimal retirement wealth boundary, and we provide an integral equation representation for the optimal retirement wealth boundary, which can be solved accurately and efficiently by using recursive integration method. As an extension, the case with stochastic labor income is also considered. The properties of the optimal strategies are provided with emphasis on the role of the mandatory retirement date and the impact of having a retirement option on the optimal financial decisions.

Genuine Savings and Sustainability with Resource Diffusion

We consider a spatial extension of genuine savings and wealth as a capital-based indicator of sustainability. In both inefficient and efficient economies, where well-being is locally or globally maximized, respectively, the well-known Hotelling rule and Hartwick (Dixit–Hammond–Hoel) investment rules and results are extended, depending on the extent of the spatial diffusion of natural capital. It is shown that the net present value of any future change in neighboring resource stocks affects the current change in intergenerational well-being. Numerical examples show the relevance of such parameters as the diffusion rate, discount rate, and marginal utility of consumption. Moreover, they suggest the exact adjustments to be made in aggregating or disaggregating the sustainability of different spatial units, which is not addressed in the current practice of green or wealth accounting.

Horizon effect on optimal retirement decision

We study an optimal consumption, investment, life insurance, and retirement decision of an economic agent who has an option to retire early any time before the mandatory retirement date. We conduct a thorough theoretical analysis for the optimal retirement problem with general utility function in the presence of mandatory retirement date, which leads to the optimal stopping problem in finite horizon. Furthermore, different marginal utility of consumption before and after retirement is considered, which can provide an explanation for the retirement-consumption puzzle, while it makes the problem technically more challenging. Based on the theory of partial differential equation, we analyze the variational inequality arising from the dual problem and establish the duality theorem. We show that the optimal retirement decision is determined by the time-varying optimal retirement wealth boundary, and we provide an integral equation representation for the optimal retirement wealth boundary, which can be solved accurately and efficiently by using recursive integration method. As an extension, the case with stochastic labor income is also considered. The properties of the optimal strategies are provided with emphasis on the role of the mandatory retirement date and the impact of having a retirement option on the optimal financial decisions.

Sustainable tourism development: A dynamic model incorporating resident spillovers

The ongoing debate on over-tourism shows that developing more sustainable forms of tourism is not only relevant for environmental reasons but it would also create important spillovers benefitting residents within the economic and social domain of sustainability. Based on this broad idea, we develop a theoretical model of sustainable tourism considering the well-being of locals incorporating external effects and trade-offs with less sustainable forms of tourism. We employ a dynamic model of resident well-being, where utility is derived from consumption, tourism quality (e.g. better restaurants, hiking trails), and the number of tourists visiting. A benevolent regional government maximizes the representative resident’s well-being by choosing the rate of consumption, the number of tourists visiting (e.g. number of beds), and the rate of investment in tourism quality. Our results depend crucially on the initial number of tourists and state of tourism quality. Suppose the initial state of tourism quality is below its long-run optimum. If initial visitor numbers are small so that increasing them raises residents’ well-being directly through consumption (i.e. more tourism supply and cultural exchange raises resident’s marginal utility of consumption), the optimal strategy is to invest in tourism quality and to increase the number of tourists over time, as quality changes. If initial visitor numbers are large, increasing them further reduces the resident’s marginal utility from consumption (e.g. booked-out restaurants, crowed hiking trails, etc.) and the optimal strategy is to increase tourism quality over time but to reduce the quantity of visitors. Our general finding is that quantity and quality may move in tandem or in opposite direction, depending on current state and residents’ preferences. If over-tourism means that residents’ well-being is negatively affected by an increasing number of visitors, the model suggests that ongoing investment in tourism quality while reducing numbers will maximize residents’ well-being. We show that the first-best optimum, achieved in a centrally planned economy, can be replicated in a decentralized economy by using time-varying tax rates. This ensures that (i) the steady state of the first-best optimum is reached and that (ii) the speed of convergence to steady state is socially optimal.

Do you need less money in retirement?

The literature has documented a one-off drop in consumption at retirement in Italy. We show that respondents’ subjective evaluation of the minimum amount of money needed “to live comfortably but not in luxury” drops at retirement as well. This finding supports the idea that, even if expenditure falls at retirement, this may have the same effect on money needed, hence no effect on the marginal utility of consumption.

Green Asset Pricing

Climate change is one of the greatest economic challenges of our time. Given the scale of the problem, the question of whether a carbon tax should be introduced is hotly-debated in policy circles. This paper studies the design of a carbon tax when environmental factors, such as air carbon-dioxide emissions (CO2), directly affect agents’ marginal utility of consumption. Our first result is that the optimal tax is determined by the shadow price of CO2 emissions. We then use asset-pricing theory to estimate this implicit price in the data and find that the optimal tax is pro-cyclical. It is therefore optimal to use the carbon tax to “cool down” the economy during booms and stimulate it in recessions. The optimal policy not only generates large welfare gains, it also reduces risk premiums and raises the average risk-free real rate. The effect of the tax on asset prices and welfare critically depends on the emission-abatement technology. JEL Classification: Q58, G12, E32

Оценка индикаторов социальной эффективности государственных капиталовложений: пример регионов Дальнего Востока

The article provides estimates of the social discount rate and regional welfare weights for the Russian Far East territories. The key parameter for their calculations is the elasticity of the marginal utility of consumption, estimated for the Russian Federation as a whole on the basis of the consumer demand function for food products. It’s revealed that for different territories should be applied different social discount rates for to assess the social effects of projects with state participation. The reason is that territories differ in the quality of life, which can be traced through interregional differences in the level and dynamic of the domestic consumer market as well as the size and structure of household income and expenditure. The social discount rate is sensitive to the future annual growth rate of household consumption in the region. If we take the actual average annual rates for 2000–2018 as forecast values, the Sakhalin Oblast has the highest social discount rate (12 per cent), and the Chukotka Autonomous Okrug has the lowest rate (7.6 per cent). Regional welfare weights show how the regions of the Far East are ranked according to the degree of impact of public investment on marginal changes in the welfare of their households. Thus, the lowest marginal increase in welfare in the Far Eastern Federal District will be observed in the Sakhalin Region, followed by the Khabarovsk Territory. From the social efficiency point this casts doubt on the choice of these regions as priority locations for large-scale public projects. On the other hand the largest effect of public projects for the improving of welfare will be observed in the Jewish Autonomous Oblast and the Zabaikalsky Krai. These regions are characterized by the highest values of regional welfare weights in the Far East for 2018, and consequently the highest marginal welfare growth for households due to public investment. It is worth noting that in 2010 the Chukotka Autonomous Okrug and Kamchatsky Krai were characterized by the highest values of the regional welfare weights in the Far East. By 2018 these two regions significantly improved their positions. Despite the fact that the regional welfare weights for most of the Far Eastern regions decreased significantly, for the Jewish Autonomous Oblast and the Zabaikalsky Krai this decrease was minimal (2 per cent and 5 per cent respectively)

Wage Growth and Equity Risk Premia

We develop a simple three-factor consumption-based asset pricing model that includes wage growth as a risk factor, and evaluate whether the model explains six major CAPM anomalies: book-to-market, investment, operating profitability, long-term return reversal, net share issues, and residual variance. Wage growth arises in the pricing kernel by using a non-separable utility over consumption and leisure, and represents the growth in the opportunity cost of enjoying leisure hours. In the model, wage growth earns a negative price of risk, that is, higher wage growth leads to a decline in leisure demand, which increases the marginal utility of consumption for an investor with risk aversion above one. The empirical cross-sectional tests show that the model explains around 50% of the cross-sectional dispersion in average returns of the joint six CAPM anomalies (160 equity portfolios). Further, the proposed model compares favorably with alternative return-based multifactor models widely used in the literature. The risk price estimates for wage growth are significantly negative, while the implied preference parameter (share of leisure) estimates are economically plausible in most cases. Overall, our results suggest that aggregate wage growth can help explaining cross-sectional equity risk premia.

Are the Fama French factors treated as risk? Evidence from CEO compensation

AbstractAsset pricing theory postulates that a risk factor correlates with individuals' marginal utility of consumption. Hence, under plausible preferences, individuals should become more risk tolerant given favorable factor returns. We show that this wealth effect predicts a positive association between performance pay and factor returns. Our results support the hypothesized relationship for the market, book‐to‐market and momentum factors. Factors constructed from bond prices are positively associated to incentives, incrementally to the Fama French factors, but we obtain mixed evidence for higher‐order market factors, liquidity factors or factors constructed from national income accounts, including pricing kernels.

Household labor supply and the gains from social insurance

The marginal gains from social income insurance programs are captured by the gap in the marginal utility of consumption across states of nature. To identify this gap in the context of the household, this paper offers a new labor-supply based approach that leverages household-level economic interactions and optimality conditions. We demonstrate that, in frameworks of efficient household allocations, spousal labor supply responses to shocks have direct implications for the gains from more generous government benefits to households. We show that this holds for both intensive and extensive margin responses under fairly general conditions. Our analysis illustrates how labor market data can be used for assessing marginal welfare gains in a general class of social insurance schemes, including the large and important programs of disability insurance and survivors benefits. Hence, household labor supply behavior and responses to shocks, which are widely studied in theoretical and empirical work, hold valuable information for the optimal design of social insurance.

The Welfare Implications of Unobserved Heterogeneity

Conditions are derived for relating household well-being functions to household utility. In particular, an isomorphic relationship between the equivalent incomes stemming from subsistence-based utility functions and well-being functions is established. This allows estimates from standard models of well-being based on a CDF (eg. probit and logit models) to be given a formal welfare interpretation. New measures of the welfare distortion due to unobserved heterogeneity are also derived. An Australian household-level dataset is used as a case study for exploring the proposed measures of distortion. The results indicate that the failure to account for unobserved heterogeneity produces significant welfare distortions (primarily in the form of under-compensation). A unique welfare sensitivity curve is also estimated that indicates the presence of non-linearities that impair the typically monotonic relationship between household income, the household’s capacity to adjust its income and its marginal utility of consumption. The results are significant for better understanding the welfare implications of tax and transfer policies.

The Health Hump

In this paper, I suggest a novel explanation for a hump-shaped age-consumption profile, based on human aging. The model integrates health in the utility function and utilizes recent estimates on the effects of health on the marginal utility of consumption. The parsimonious model has a closed-form solution for the age of peak consumption and the consumption level at that age relative to initial consumption. A calibration of the model with data from gerontology produces an empirically plausible hump in consumption.

THE HEALTH HUMP

AbstractIn this paper, I suggest a novel explanation for a hump-shaped age-consumption profile, based on human aging. The model integrates health in the utility function and utilizes recent estimates of the effects of health on the marginal utility of consumption. The parsimonious model has a closed-form solution for the age of peak consumption and the consumption level at that age relative to initial consumption. A calibration of the model with data from gerontology produces an empirically plausible hump in consumption.

Optimal Monetary Policy in an Overlapping Generations Model with Search Theoretic Monetary Exchange

AbstractIt is well-known that in the monetary OLG models, a deviation from the Friedman rule can improve welfare because it generates intergenerational wealth transfers; however, the rule becomes optimal if the age-specific lump-sum tax policy is available. We revisit the issue using a microfounded model of money with centralized and decentralized markets. The individuals live for two periods. The young individuals work, receive wage income and hold money and capital in the centralized market. They also trade goods in the decentralized markets either as a buyer or a seller. Only money is accepted as a means of payment in the decentralized markets. The old individuals consume all their wealth in the centralized market. The quantity in the decentralized market negatively depends on the seller’s wealth, because the marginal utility of consumption in the centralized market is diminishing, but the buyer takes it as exogenous. Therefore, the equilibrium wealth exceeds the socially optimal level under the Friedman rule. A positive nominal interest rate makes money holdings costly, reduces wealth and improves welfare, even if the government optimally uses the age-specific tax.

Are the Fama French Factors Treated as Risk? Evidence from CEO Compensation

Asset pricing theory postulates that a risk factor correlates with individuals' marginal utility of consumption. Hence, under plausible preferences, individuals should become more risk tolerant given favorable factor returns. We show that this wealth effect predicts a positive association between performance pay in observed contracts and factor returns, and test this prediction empirically with commonly-used asset pricing factors, such as the Fama French and momentum factors. Over the period 1992-2014, our empirical results support the hypothesized relationship for the market, book-to-market and momentum factors. These relationships appear to be driven by the delta of options, and for the market factor, stock grants. We also find that factors constructed from bond prices are positively associated to incentives, incrementally to the Fama French factors, but obtain mixed evidence for higher-order market factors, liquidity factors or factors constructed from national income accounts, including pricing kernels.

Euler equation estimation: Children and credit constraints

Conventional estimators based on the consumption Euler equation, intensively used in studies of intertemporal consumption behavior, produce biased estimates of the effect of children on the marginal utility of consumption if consumers face credit constraints. As a more constructive contribution, I propose a tractable approach to obtaining bounds on the effect of children on the marginal utility of consumption. I estimate these bounds using the Panel Study of Income Dynamics and find that conventional estimators yield point estimates that are above the upper bound. Children might, thus, not increase the marginal utility of consumption as much as previously assumed. Consumption Euler equation estimation credit constraints children demographics life cycle bounds D12 D14 D91

A Stated Preference Approach to Assess whether Health Status Impacts on Marginal Utility of Consumption.

A sample of Danish citizens (n = 2000) was asked to participate in a hypothetical experiment in which they could self-insure against a certain loss in income across two periods of time (one in which the person is in good health and one in which the person is in poorer health). Our results suggest that reduced health impacts on the marginal utility of consumption, but not in a linear fashion. Amongst a majority of respondents inferior, health increases the marginal utility of consumption for intermediate health states, whereas this is not the case for less and more severe health states. Copyright © 2016 John Wiley & Sons, Ltd.

Leisure Preferences, Long-Run Risks, and Human Capital Returns

We analyze the contribution of leisure preferences to a model of long-run risks in leisure and consumption growth. The marginal utility of consumption is affected by short- and long-run risks in leisure under nonseparable and recursive preferences. We match equity risk premia and macroeconomic moments with plausible coefficients of relative-risk aversion. Additionally, the model generates a less negative to positively sloped average real yield curve, depending on the elasticity of substitution between the consumption of nondurables and services and leisure. Further, the incorporation of leisure in utility allows us to derive model implications for the return on human capital.Received October 11, 2011; accepted December 24, 2015 by Editor Wayne Ferson.

Myopic preferences or subsistence income among rickshaw cyclists

Purpose – The purpose of this paper is to investigate why poor people make decisions that at first sight appear irrational. The author stays within the realms of classical consumption theory, and investigates preference-based explanations. The author studies the case of rickshaw rental versus purchase. One-year rent is sufficient to buy a rickshaw in the plains of Nepal, while a rickshaw will last many years, so purchase appears very profitable. Still most cyclists rent the rickshaw. Design/methodology/approach – Based on choices made by rickshaw cyclists between hypothetical financing schemes for rickshaws we investigate whether the explanation is a high time-preference rate or a high elasticity of the marginal utility of consumption, which in turn can be explained by preferences that are formed by consumption near a subsistence level. Findings – The authors find that subsistence constraints are more important than high time-preference rates. In short, many rickshaw cyclists switch from profitable investment decisions to myopic choices if the weekly payments are too high. Research limitations/implications – In contrast to standard bidding-forms, the methodology does not allow for exact estimates of the implied time-preference rate or the elasticity of the marginal utility of consumption. Practical implications – Microcredit has no role if people are subsistence constraint, as they will need to save every day also to repay loans. Social implications – The findings indicate that myopic choices by poor people are not due to myopic preferences, but rather that the disutility of reducing consumption today is too high. Originality/value – The authors believe bidding-forms are too complex for field experiments among people with no, or minimal, education. The simple hypothetical choices we have constructed appear to work.